Tuesday, August 21, 2007

Shining A Light in the Corner (Re-Run)

As the second anniversary of Hurricane Katrina approaches, I've been reviewing some of my comments on its aftermath. Many seem as relevant today as they did then. The following posting from September 2005 considers what Katrina revealed about the state of the US petroleum refining sector:

For most of the time that I have been involved in the energy business, with the exception of the last few years and a couple of brief windows that closed quite rapidly, the refining segment of the industry has been the least glamorous, least appreciated, and least career-advancing part of the industry to be associated with. In the aftermath of an almost-worst-case event for the US Gulf Coast oil and gas industry, we appreciate rather more the work that refineries do and how delicately balanced the whole system is. The best summation of the pivotal nature of these unappealing beasts is from the Saudi Oil Minister, who said, "We cannot keep producing oil with no refineries. There is a limit."

Part of the reason for the pickle we're in--in addition to poor historic returns and the costs and difficulties associated with permitting and environmental regulations--is that the industry finally escaped its vicious cycle of overbuilding every time the margins looked healthy. In fact, it had quite a bit of help in this regard from the government, which broke the back of the earlier independent refining sector (i.e., pre-Valero) with a series of environmental regulations that added enormously to the capital cost of the business without changing the products in a way that anyone seemed willing to pay even a penny more for. Only the majors and the largest independents could play that game for long, and even the majors tired of it, selling off dozens of refineries in the 1980s and 1990s, and even demolishing a few along the way.

Now, many of those regulations were necessary and beneficial. We can all see the consequences, though: an industry that couldn't withstand even a much smaller disaster than Katrina without severe disruptions, but that's finally making a healthy profit, for which it is widely reviled. Just as importantly, since Katrina a number of folks have been going through the numbers and have suddenly realized that the US doesn't just import vast quantities of crude oil. We also import between one and two million barrels per day of refined products that we lack the capacity to produce for ourselves. These quantities will only grow, until we get our consumption of transportation fuels under control, or find a good alternative.

These imports have consequences for the country as a whole, and for environmental regulators, in particular. So far, whenever we've wanted to tighten the specifications on the gasoline and diesel fuel sold in this country, to reduce their impact on the environment, the burden has fallen entirely on a domestic industry with no alternative but to comply. What else were the oil companies going to do, dismantle their refineries and move them to China? Now we've grown reliant on imports. When we want to reduce sulfur, aromatic compounds, or some other component or impurity further, will our foreign suppliers rush to comply? Will they invest in extra capacity to supply us, when other markets are growing at least as rapidly, but are less finicky about quality? And which will be the first company to build a new refinery in the US--with permits rushed through a worried Congress, perhaps--in the certain knowledge that the moment it starts up will be the beginning of a long slide back to returns you wouldn't accept on a bank cd?

Of course, the alternative is to nationalize them all and turn the whole downstream part of the oil industry into a utility, which is how we seem to expect it to behave most of the time, anyway. Somehow I can't imagine that outcome delivering anything like the kind of reliability and efficiency that the profit motive has done for over a century. If you are skeptical about that, there are plenty of examples to look at in other countries.

In an odd way, Katrina has done the same thing for oil refining that the 2003 Northeast Blackout did for electric power distribution. It has shined a light into a dark corner of the energy industry and scared the daylights out of anyone who bothered to look. What is waiting in the other dark corners, as a result of two decades of the expanding disconnection between our appetite for more energy and our low regard for the means of producing it?

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